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Guest Post: TIPS Vs Treasuries
Submitted by Jeff Borack of Kerrisdale Capital
TIPS vs Treasuries
Treasury Inflation Protected Securities are government issued
securities adjusted bi-annually for inflation. When the urban consumer
price index (CPI-U) increases, the face value and the yield on TIPS
also increases. If investors are concerned about inflation, TIPS are
one method of protection (you can buy them directly from the government
here: http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm) given that they are directly tied to inflation. Unlike other investments which “should” appreciate in an inflationary environment, TIPS do appreciate.
The spread between TIPS and Treasuries represents the market’s
inflation expectation. It’s just as impossible for the government to
default on TIPS as Treasuries, so default risk is the same. Investors
will accept a lower yield on TIPS by the amount they expect to recoup
from inflation adjustments. While investors who hold normal treasuries
to maturity are guaranteeing their interest rate, TIPS holders are guaranteeing their purchasing power,
making TIPS an attractive alternative for many savers. The chart from
Bloomberg below shows the current yields available on TIPS in green,
and treasuries in orange:
As we can see here, the 2-year spread between TIPS and Treasuries is
a bit over one percent. The 5-year spread is at about 1.75%, and the
10-year spread is a little over 2%. It’s a bit surprising to see such
low spreads given the inflation expectations investors claim to have. Everywhere we look, investors are fretting about inflation… why aren’t they buying TIPS?
Even if we were not expecting an inflationary environment, TIPS might still be cheap relative to treasuries. The chart below plots the year-over-year percent change in CPI-U as of last month:
The average annual inflation over this time period has been 3.8%.
The chart is volatile, and there have been lengthy multi-year periods
where inflation has been less than 2%. But even if we assume a normal
inflation rate will be only 3% per year, investors can reduce their
risk of losing significant purchasing power and increase
their expected return by about 1%, by moving from treasuries (and CDs
and savings accounts) into TIPS. The combination of lower risk and
higher return is a rare opportunity in finance. We’re at a loss to
understand why investors (especially those with inflation fears) would
hold treasuries, CDs, or excess cash when they could buy TIPS.
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"We’re at a loss to understand why investors (especially those with inflation fears) would hold treasuries, CDs, or excess cash when they could buy TIPS."
'Cause the CPI is rigged?
Right, there's a MASSIVE ($$$$) incentive to mistate inflation. When so much is indexed to it (for example a little thing called social security), we know which way TPTB would like inflation to go.
Yeah the Best minds in the country have been working on the CPI formula ( Prof Boskin at Stanford and others). Given that some 30% of the number is Imputed Rents ( a joke ) and manufactured goods are adjusted hedonically - CPI in the US is just about mandated by law to be under 2%. They should just write that into the constitution and be done with it - so all those bright minds can do something productive and maybe learn to sing songs or something.
Plus the taxation on TIPS is a big fucking raw deal.
Maybe investors would rather compound a higher coupon rate? No one has made money investing in TIPS to date, the money in TIPS is made trading the bonds. THeir inflation indictive spread is distorted because TIPS are flight to 'quality'bonds just like other treasuries. A completely useless scam that allows the government to issue bonds with crap coupons. Inflation statistics are dubious in their very nature and the margin of error probably is big enough to completely cancel the coupon payments of TIPS more often than not. Yah do the math and exist outside of reality. TIPS are attractive to the government as a way to save money. THeoretically and practically they are crap. The so called theory of the spread to nominal treasuries is nothing but circular logic. TIPS are inspired by the same stupid thinking that has the world in artificially low interest rates such that no sane investor would invest for the poor return which has no chance of compensating for the risk of actual investing. In a head up your ass world thanks for the tips...
if you read Toporofski you would realize that TIPS are most likely to have a good payoff when the government can least afford to pay them off and in fact defaults. Are you sure you aren't a subsidiary of Barclays promoting TIPS to be bought at a high price (low yield) hey bought a few months ago at a low price (high yield)?
Go back to school where you belong.
if you read Toporowski (Minkski GaNG)you would realize that TIPS are most likely to have a good payoff when the government can least afford to pay them off and in fact defaults. Are you sure you aren't a subsidiary of Barclays promoting ToIPS to be bought at a high price (low yield) hey bought a few months ago at a low price (high yiELD)
(Its a shame Minski et al are labeled economists snce they are not morons like most modern 'economists' the epitome of de-education slavering to the 'ideology' of fiction of their only chance at employment at the FED the leading moron government stooges that wouldn't know an economy if they saw one and won't probably notice when this one comes crashing down around them as they argue Keneysian versus neo morons from chicago or such...it serves the crooked politicians to have these estemed misguided idiots deluding the populous with notions anything makes sense at all.
And the interest payment is made by ponzai... I mean borrowing more money?
But are not TIPS still tied to a CPI scam whereby the Feds do everything possible through the magic known as shrinkage, substitution and hedonics to LIMIT the level of reported inflation in order to reduce Social Security COLA and what they pay out in interest on ALL Treasuries, including TIPS? It would seem to me that one would still not be getting true inflation protection, but rather a government gamed figure.
One need only do one's own food shopping to understand what is going on.
your bang on with the food shopping....is there a legitimate consumer grocery index anywhere?? and i am not talking about some BLS bullshit... i havent researched that yet just a thought....
John Williams has the best inflation data out there ... along with a lot of other reconstructed government data that tells the truth versus the garbage we are fed:
http://www.shadowstats.com/
thank you. i do know about john williams...i am looking for something strictly grocery related...does he focus in deeply on that at all?..i am talking price per lb on everything in the grocery store from generics to name brands from 76% lean beef up to 90% lean the whole shibang..
aurum,
ever wondered WHY when then CPI's figures are released, they LEAVE out the cost for fuel, and FOOD?.
Their skewed even w/out those, just off the top of my head from shopping weekly/Bi-weekly, for usually the exact same items....
What I was paying for them a year ago, and now, has about a 25-45% spread.................
That's for regular sized packages.
What's really telling, is you go to buy an item, that used to be 4pkgs per pack, now it's 3 per pack, and the price is same.
That's a 33-1/3% difference...........
Eggs, Dz Large AA Grade, $1.89, were $0.89dz.,,in one year.
Anything w/grains, is WAY up, anything that EATS grain, is also.
Heard last week, due to increases in grains(Corn), expect a minimum 25% increase in all meats and Poultry this summer......So, suggest stocking up.
Oh, OT but, Ammnishun, 5.56/.223, is back to $400.00m........
Want some, best snag it while you can.Most calibers back in stores/online, but still 50% over 24 mos ago.
Something else to keep an eye on.
http://www.nraila.org/Legislation/Read.aspx?ID=5843
"your bang on with the food shopping....is there a legitimate consumer grocery index anywhere??"
Just go to the same store each week and note down the cost of a 24 can pack of Busch Beer. Grain, energy, aluminum, distribution. You will have it all in one simple index.
Excellent!
Worked in the budget office of a government organization that was funded by user fees. Fee changes were limited to annual changes in CPI-U. When submitting future year (outyear) budget estimates, had to use OMB's CPI-U estimates for the fee side of the equation. It was always amazing to see how offiical CPI estimates always seemed to be optimistically low, while GDP estimates were always exceptionally rosy and assumed no downturns in a rip-roaring, aging business cycle. Many a discussion was had about how reported CPI numbers did not match what we were seeing in our everyday lives.
Anyone who has faith that a grossly overextended gov't is going to accurately report CPI, when these numbers can have massive impacts on spending commitments, and have been fudged for an extended period already, is deluding themselves.
As far as the "safety" being comparable to regular Treasuries, I hope that the day never comes when the US's creditors have to take a haircut - whether directly or indirectly via inflation. However, failing to take into account that it could happen could be a fatal blunder as an investor.
Also, as the gov't sells more of these types of securities (because investors don't want to be locked into longer term treasuries), I would imagine that the effective average maturity of gov't debt shortens, making the gov't even more exposed to a funding crisis.
I love writeups like this by analysts wearing rose-colored glasses. Short-term, it might be a nice play if enough other suckers buy into the thesis. Long-term, the problem with TIPs will become apparent to a much larger audience.
CPI doesn't have to be a scam to be wrong by huge margins -its an arbitrary statistic! The mindset here in comment land is there is underlying logic as if statistician and economists were scienctists and actually knew what they were doing...they don't know and are not scientists they are charlatans rain men who make predictions based on old news statistics which have no predictive truth and in fact more often than not creating self fulfilling economic 'situations'. Read about positivism and you'll get the idea. Basically thinking they know what they are doing is identical to economists believing what they are doing has a basis in reality and neither does. gET IT?
seems believing the books are cooked is a vote "they really know what they are doing"-vote for Bush next round the "Stupid like me President" buying chickens though is practical and makes sense and I am sure Fidel would agree on
the chickens....
CPI doesn't have to be a scam to be wrong by huge margins -its an arbitrary statistic! The mindset here in comment land is there is underlying logic as if statistician and economists were scienctists and actually knew what they were doing...they don't know and are not scientists they are charlatans rain men who make predictions based on old news statistics which have no predictive truth and in fact more often than not creating self fulfilling economic 'situations'. Read about positivism and you'll get the idea. Basically thinking they know what they are doing is identical to economists believing what they are doing has a basis in reality and neither does. gET IT?
seems believing the books are cooked is a vote "they really know what they are doing"-vote for Bush next round the "Stupid like me President" buying chickens though is practical and makes sense and I am sure Fidel would agree on
the chickens....
Govt will be unable to inflate their way out of this massive credit binge of 30 years. The last 30 years WAS the INFLATION...
Now we DEFLATE, DEFAULT, AND DOWNSIZE till we meet true DEMAND.
Nope, the inflation is mostly still all overseas, with the owners of treasuries and those who have stockpiled dollars.
All of which can come back onto our shores at a moment's notice, dragging every exportable good out of our country, and leaving behind Zimbabwe-esque ruin in its wake.
But sure, fine, hold them dollars. More real goods for me (and the government-who is stealing from you every second you hold those dollars).
Tmosley
you have been reading a lot of jim willie articles i bet. not saying i totally disagree with you, but a lot of things have to happen before things come back to our shores on a moments notice. it's irrelevant anyways.
those who believe the rest of the world is so rosy and capable of maintaining growth are misguided at best and dangerous at worst.
you people who talk about "more real goods for me" are foolish and oblivious. get over yourself.
oh and by the way what are all these exportable goods you speak of and who's coming over to take them away???
I don't think I have ever read a Jim Willie article. I speak from my own understanding of the world, who has the paper, who makes the paper, who has the goods, and who makes the goods.
Exportable goods consist of anything that is for sale in America that is worth taking out of the country. All foreigners have to do is start buying using their huge surpluses of dollars. This could happen at a moments notice. It will likely come in the form of panic buying of commodities, which will be taken for delivery. Prices on scrap metal will explode as foreigners seek to unload their dollars. At this point, thievery will run rampant, where we will see thinks like railroad tracks and power lines being stolen (there is a great deal of precedent for this in Russia). Even individuals, strapped for cash to pay for rapidly increasing food bills (due to the aforementioned commodity pull) may resort to pulling their own wiring to raise cash.
It's not that the rest of the world is so rosy, it's that the United States has ruined any chance of a recovery, and continues to make things worse. These people have destroyed our industry. The only thing we have left to export is inflation, and it won't be long before foreigners realize it. When that day comes, things will get real nasty real fast.
Also, you might want to consider getting over YOURSELF before giving that advise to others. People like you who think that paper is valuable can keep it. I'll take the goods that will hold their value. You can get stolen from all you want. It's fine by me.
I believe you have contradicted yourself in your own posting. If dollars were to repatriate, it would send their value up since it's a reserve currency. Remember the 2008 dollar squeeze?
http://jessescrossroadscafe.blogspot.com/2008/10/short-term-imbalance-in...
So more dollars chasing after the same amount of goods makes them worth more?
Check your math.
The 2008 dollar squeeze came from companies wanting to SELL assets for dollars. This is the opposite effect, a panic selling of dollars for real assets.
The monetary base in the US is about $2T, far less than reserves around the world. These reserves are required for many reasons include energy, gold purchases and local currency stabilization. So assuming every nation with any substantial USD reserves were able to dump these notes onto the market, you must first ask yourself how they can do this. Purchases of alternative currencies such as the Euro will have a negative effect effect on the EU and send it bankrupt let alone even possible due to it's availability. Oil and gold purchases will exponentially raise the price of these commodities and possibly leave the acquiring nation holding a large "reserve" of non performing assets.
But now assume that the dollars make it back into the US which is not necessarily the case unless you trade with the US. The effect would be a return to prosperity for the US and crush all competing industries world wide since the US becomes a single port of commerce and trade, ala China. Once US dollar reserves build up in the US, the treasury can simply sterilize them out of existence through Treasury purchases. That's what China does to peg the Yuan.
More dollars chasing more goods with rising wages is sustainable.
K-wave winter's massive deflationary impact meets a determined inflationista in Bubbles R' Us Ben. Tea party and the like could crimp Bubble's style and be a game changer. However, if Bubbles continues to fight deflation with a printing press and huge stockpiles of electronic paper and ink, we may wind up instead in a large and violent trading range for a while until the deflation/inflation debate definitively breaks one way or another.
From what I can tell there are only 2 ways in which inflation can be stoked;
1) Massive increase in worker pay across the globe.
2) Destruciton of fiat currency, and thus civilization.
So those buying TIPS and/or GOLD are betting on one the two (or both) outcome. As far as I can see neither is likely.
There is a third way. A currency can collapse (leading to hyperinflation) if there is widespread loss of confidence in that currency. I think there would likely be hyperinflation in the US if the dollar was ever dethroned as the world's reserve currency due to banks around the world dumping large amounts of dollars into circulation. I read there are currently more dollars outside the US than in the US.
which is to say: first 2), then 1).
I think I need to just copy past this on every thread because it is obvious that 99% of the population does not get this. You do not need more money to enter a system to cause hyperinflation, only a loss of goods and services (i.e. massive consumption).
My God Tyler, did you get hacked by Ben Bernanke!?
Looking to TIPS for protection against inflation is dropping your baby in a den of dingoes. CPI is no more a valid measurement of inflation than the USDX is a valid measurement of the purchasing power of the dollar. CPI only measures a bunch of crap that you don't need (while excluding "volatile" food and energy costs), and includes numerous nonsensical adjustments to keep it down (hedonics, etc).
Don't EVER, EVER, EVER buy TIPS or any type of treasury! They are a sucker's bet, suitable only for large countries that want to use their posession as a club for use in diplomacy.
Well said TMosley!
I found this article downright insulting as well. If I wanted mainstream, pro-establishment, sure-to-lose investment advice, I would just hang on every word from Obama, Geithner and Bernanke instead.
Tyler, you can do better than this! Or are you just trying to rile up the plebs with a purposefully disingenuous circus?
are you two letting your emotions get in the way of your thinking??
lol, are you letting your stupidity get in the way of any form of logical thinking?
TRUST THE GOVERNMENT.
OBEY.
DO NOT SAVE.
huh? who's saying that?
your fallacy is laid to rest at the point where I do neither of the 3.
Just sayin', won't matter what you cling to when the things you need aren't available, dear sirs.
Yours truly is long cash and grains for when gold hyperinflates vs foods.
Well, well, won't that just be a unique condition--one that has never happened before in the history of the planet Earth.
So yeah, you do that.
On the contrary, TMosely and I were both just indignant at seeing how Leo has once again allowed his pollyannish and implicitly mainstream, pro-establishment sentiments to get in HIS way of making an intelligent and well-reasoned argument, instead of just rehashing and repeating more mindless status-quo propaganda.
Interview With Jim Rogers: The CPI Is a Lie and Inflation Is Going to Increase by Ron Hera of Hera Research Newsletter (HRN) | Business Insider | Jun. 3, 2010
EXCERPT:
HRN: You mentioned that the US is the largest debtor nation in the history of the world. Do you think that will lead to high inflation or hyperinflation in the US?
Jim Rogers: Well, there will be inflation. First, you have to have inflation before you can have hyperinflation. I mean, we have inflation now. If you go to the shop, whether it’s groceries, or education or insurance or health care, prices are going up for everything. The government lies about it in the US. Some countries lie, many countries don’t: Australia, China, India and Norway. Many countries don’t lie about it and acknowledge that we have inflation. Others lie about it, the UK and the US, but if you go shopping you know prices are up.
HRN: Are you saying that the American Consumer Price Index (CPI) published by the US Bureau of Labor Statistics is a lie?
Jim Rogers: In my opinion, yes, of course it is. Have you looked at it? They’ve changed their accounting several times in the past few decades. When housing was 20% to 25% of the CPI and housing was going up, they didn’t count it, saying rents weren’t going up, and then when home prices started going down, they counted it. It’s the same with many things. It’s staggering some of the tortuous reasoning that the BLS has used over the past 25 or 30 years. When the price of gasoline goes up, they say it’s not really going up because it’s better gasoline, better quality, therefore you’re getting more for your money. I mean, it’s endless, the stuff that they say and for some reason people sit there, although more and more people are catching on, and accept what the government says. As I said, in other countries, they acknowledge that there’s inflation. I don’t know how there could be inflation in Australia and not in the US; how you can have inflation in Norway or India and not in the US, but the US says there’s no inflation.
HRN: An article in the Telegraph by Ambrose Evans-Pritchard reported this week that the US Federal Reserve’s M3 monetary aggregate is estimated to be contracting at an accelerating rate, in other words, deflation.
Jim Rogers: What’s going down in price in the US economy? I’d like to know where you shop. We know home prices are down. Oil prices are down to $73 per barrel, if you’re talking about a monthly or quarterly basis, or even an annual basis. I’m talking about what’s going on in the big picture. Where is the deflation in the US?
HRN: Some people believe a contraction of M3 indicates deflation.
Jim Rogers: Is M3 something you buy in a shop? M3 can lead to changes in the price structure, but M3 is not price inflation or deflation.
Read more: http://www.businessinsider.com/jim-rogers-inflation-2010-6#ixzz0pzkIg0dE
But isn't the massive amount of debt destruction that is and will continue to go one deflationary?
There was a huge shortage of paper marks even though Havenstien was printing 74 million,million,million (74 quintillion) marks a week. (Fergusson 1975)
I think Jim is reminding people of that, in a round about way.
Yes, I think debt destruction is deflationary, although it's being offset by stimulus. I'm surprised at some of what Rogers said. I agree that the CPI is a baldfaced lie, but him asking how there can be inflation in Australia, India, and Norway, while there is little in the US or the UK, is misleading. If the US dollar and pound weren't being inflated but the other currencies were, then you'd see that kind of divergence. Inflation isn't the price of gas or whatever going up. It's prices going up across the board. Oil could go to $200 a barrel, and it wouldn't be inflationary if the money supply held constant. In that case the price of some other things, more discretionary things, would fall. In part, I think we haven't seen as much deflation because of subsidies like Cash For Clunkers, the homebuyer credit, and so on. Without these, the price declines in autos and houses would be more severe.
Imagine you are driving along in a car, and you have one foot on the gas, and one foot on the break. You are moving along at a fairly normal speed. The extra gas usage is negating the extra friction from the breaks. Things seem to be fine, but when you look ahead, you realize that eventually, you are either going to run out of gas, or your breaks are going to wear out. You might think that there is an even chance of either happening, or maybe both will happen at the same time, meaning you'll just coast on for a long time after you are out. But then, you look in your back seat. There he is, Ben Bernanke, with a massive syphon tube shoved straight up his ass, pouring his "natural gas" into your tank. It's not that much right now, but you know that he can ramp it up at any time. Now you panic, because you realize that that man has an inexahstable supply of "Federal Reserve Gas" (FRG) and that because of that, the car will not stop, but will instead accelerate out of control as soon as the breaks are overcome. You try to talk sense with him. You try to tell him to let you stop the car, but that man knows he wants to get "somewhere" (he doesn't know where), and he wants to get there fast. He won't stop producing gas for any reason. Indeed, he has said so in the past. You try to push down harder on the break, but he just increases the gas. He doesn't seem to know or care when the break lining will go bad, or that the rate at which he is outputting FRG, they will likely rocket straight into a brick wall as soon as the breaks fail.
You see? The amount of debt that is defaulting is massive, but it is a finite number. The amount that can be printed, though fairly low right now, can be done with no fundamental limit, and we have a man at the helm that is willing to throw money out of helicopters to keep from stopping.
Fantastic narrative. We can’t have a country run by a group of thieves. They’ve outlived their 15 minutes of fame. The Internet, a la Tyler Durden et al., has torn down the reputation of the oligarchs’ self-serving financial system.
Very nice indeed. With very little treatment this will make an excellent old school Twilight Zone episode. "It started off as a quiet Sunday drive and led straight into the Twilight Zone"
it's all about when you buy. I bought tips bonds at about 90% of par and regular bonds (muni's) at a bit less I think. so you wait until the idiots have to delever again in this crash up happening again and you will get good buys. so I got long term inflation protecion at 90 cents on the dollar. I'm not complaining. and long term munis at less.
If I had a gun to the head, I would gladly pick TIPS over treasuries.
Luckily, the government hasn't put that gun to my head yet. For now they let me keep pretending I'll actually be able to cash out my retirement accounts tax-free in the future and make my own investments.
Hahahaha! You're going to trust the dirty Feds not to change the CPI again to understate inflation?
Suckers.
This is not the time to buy TIPS at all. I was buying I-bonds since Nov. when they were paying 3.36%, and stopped when they lowered them to 1.74% in May. However, the I-bonds are still paying more than TIPS. When you buy TIPS and then try to sell them before maturity you have to pay a $45 transaction fee per security. I-bonds have no transaction cost to sell or redeem. I-bonds are also tied to the CPI-U, which as everyone has already figured out, is rigged. TIPS can be sold anytime after purchase like any bill or note, but I-bonds have to be held at least a year before you can sell them. In serious deflationary situations which we have been in, I-bonds never go below 0%, because if ever the CPI-U were to go negative, the fixed rate is raised to compensate. TIPS do not work this way. I-bonds adjust just like TIPS every six months, and can adjust higher than a TIPS if the fixed rate portion moves up as well.
I-bonds are a better option by far, when it comes to buying inflation protected securities. I would not be surprised if we didn't see a TIPS auction for a while, until rates get higher. No one wants them except Bernanke right now, just so they don't have a failed auction. If they chose to do another TIPS soon, there will be no buyers for sure. People are flipping short term bills right now, because frankly there is nothing out there in Treasury land to buy right now. When they decide to report the CPI-U correctly instead of rigging it, there will be more demand.
this is Bernanke's game, don't you ever buy this, if you need to buy Treasuries, buy shortest maturity rate, only few months...get your money back when the inflation hits and demand a higher rate, again short duration, fight with the Fed this way.. they will give up anyway at some time in the near future and go for hyperinflation.
Real interest rates ( represented by TIPS) are too low now - given sovereign risks. If you want to play the inflation implied you would have to short nominal Treasuries against TIPS - currently a negative carry trade. And Please dont use those damned inverse and double inverse ETFs - its not the same as shorting.
Did you know that if the index goes up 10% on Monday and down 10% on Tuesday - you LOSE 4% on BOTH the Double ETF and the Double Inverse ETF? Do the arithmetic yourself.
Inflation is not going to be the problem. Just as equities "underperforming" is not going to be the problem. Those euphemism were OK in a gentler age - Now we live in the age of the Flash Crash. No inflation - then Boom - one fine day the Dollar loses 50% and hyperinflation. Equities nice and quiet - and dedicated stock pickers heave a sigh of relief and start finetuning their valuation estimates - the Boom- equities go down 30% in 10 minutes. That kind of thing. Markets are no longer gracefully adjusting - they phase-shift. Which makes it hard for anyone to make any money. 3 month T-Bills look like a fine investment to me .
The CPI is rigged! Plus, why would anybody choose to buy a government liability, especially in the era of sovereign debt defaults. Just buy physical gold for inflation protection....it's not a government IOU, it's a true, real asset!
The area in the second chart between 1979-1981/82 is exactly where we are headed. Plan accordingly. Boob Bernanke might have studied the depression, but he obviously learned absolutely nothing. He made and is making the exact same mistakes on a larger scale. I would not be surprised to see inflation between 5-6% by the end of this year, and continuing higher through next year. The FED will be forced to inflate soon, and inflate big. I don't think Americans are going to allow anymore bailouts or trillion dollar QE's anymore. That leaves inflating as the only resolution to this debt problem. Additional QE would only kick the can down the road again for another year anyway. Then you are right back where you were, having to inflate even more.
I think the point of this article is that if you feel the need to buy treasuries, buy TIPS. That is good advice. But if you want real inflation protection, you probably need to look elsewhere.
Premise: CPI is an accurate measure of inflation
No thanks!
Why are you so surprised? Investors with money and the means understand the mechanics of the economy a lot more than bloggers. If they are willing to bet billions on deflation, then chances are.......
My question is, can the bond market trump the government's CPI-U? In other words, can the demand (or lack of) for TIPS raise the yield and reduce the spread?
If by "investors" you mean "central banks", who are the only ones buying treasuries, then I would have to disagree with you. People playing with money that they don't even see as belonging to other people will always make the worst decisions possible, for political reasons.
If inflation increases by any significant degree it will bankrupt the US Government due to the interest expense rising. It will also cripple the housing market and the overall economy, decreasing tax revenue at the same time. Buying insurance in any form from a bankrupt intity is futile (think AIG).
i put my 90 year old mom in TIPs. we did this a few years ago, when the auctions often priced the bills at a discount. the last time we bought they went at a premium as FedTreasury front runs everything. the other thing is duration, as the best TIPS are probably the 5 years. as you go out the fixed rate component doesn't expand much. iw ould like to see those charts. now after laddering a position in the bonds, we put on some oPimcos short duration TIP fund, which should balance the position, also their TIP bond fund is not tied to CPI, its tied to the Merrill Lynch index I think. Brokers will tell you to buy the etf, but that only follows the current pricing, which is great if you buy ahead of the inflationary rise, buying the physical bonds while inflation expectations are low, and then balancing with a fund later seems like the thing to do.
the only thing about buying a tip at auction and it prices at a discount is the tax liability on the difference. you pay that on your current taxes.
There's a lot of ZH'ers favouring inflation, and the inflation vs deflation debate never ceases to devolve into emotion and name-calling (which is quite weird, when I sit back and reflect on it), so with hands at the ready near my ears to soften the blow, I would like to point out that the phenomena brought to light by Tyler and Jeff via the analysis of TIPS versus regular treasuries is corroborated by both CD rates and bank retail lending rates (and basically every other marketable debt category).
As many have already noted in the comments, CPI-U is not a true measure of inflation. ShadowStats may have a better handle on real inflation, but then again Mish Shedlock has some valid alternate measures.
But the brokenness or otherwise of the official CPI figures in the US is not deceiving the market participants here, IMV. To suggest that they (which, incidentally, refers to participants on both sides of the trade) are basing their capital allocation decisions on a broken metric from one country is a flawed assumption. Pick any large economy you like and take a look at their TIPS equivalent. Take a look at their bank CD rates and bank lending rates.
The picture is clear - no matter what major country:
Here 'aren't currently concerned' means the walk they are walking, the 'talk' they are talking might be subtly different. But it's where and how they are allocating their capital that matters.
The 'money printing' argument is thin also. Even if it is true that the USA has printed substantial amounts of money, by looking at the same metrics other major countries that have not conducted any substantial printing you will see basically the same story - rates are all in the same ballpark.
I will always remain on alert to the possibility that a government can indeed decide to ensure it's own destruction by ramping the presses, but I think a wise approach is to accept what the markets are consistently telling us - that hyperinflation is not on the horizon (yet).
However, I still remain skeptical that many countries would be stupid enough to intentionally hyperinflate via printing, particularly with previous historical examples such as Zimbabwe and Germany still present in the collective mind, and also because hyperinflation does great damage to the banksters books (having their loans repaid in weak currency is a banks nightmare).
Serious inflation? Clearly not yet. Later? Maybe, but the jury is out.
Updated DOW charts :
http://stockmarket618.wordpress.com
http://www.zerohedge.com/forum/latest-market-outlook-1
Bingo ya'll!! Buying TIPS from the US govt is basically like buyinmg credit default protection on AIG - from AIG!!! Why?
1. Given the massive amounts of leverage in the system - any large increase in inflation and resulting spike in interest rates will lead to Default. Yes govts do default. So TIPS will be defaulted on in the event of very high inflation - QED.
So - you are actually better off buying nominal long Treasuries at the 3-4% interes rates. This would be a bet that the US govt remains solvent. A reasonable bet - with risk of course.
Buying TIPS is a bet that the US govt will fail - inflatrion will skyrocket etc. In which case say bye bye to your money. This is NOT a reasonable bet because it is a lose-lose proposition. If the govt stays in control and keeps inflation really low /deflation - then you get almost nothing on your money. If the govt loses control and loses control over inflation - you get nothing on your money and you dont even get your money back.
The more TIPS are issued, the more the US government is playing with fire. Inflation-proof debt removes the power of the printing-press. It puts an independent government (which issues its own currency) - into the position of one which is trapped - like Greece.
As commenters have said above (a) will occur then (b):
a) lying about the inflation rate (deeming it lower than reality)
b) default completely on TIPS just when they are most profitable for investors.
The further problem is that TIPS are only the tip of the iceberg. The government has committed itself to a huge swathe of inflation-linked obligations - government pensions and other defined benefits. This has dulled the power of the printing press - such that a major level of defaulting is inevitable.
TIPs actually work pretty well in deflation too. most fixed income investors are stuck at the short end of the curve, TIPs allows you a way to get out there without risking points if yields suddenly turn higher. its not likely rates will rise without inflation. two points, this is not rocket science, but inflation is running ahead of equivalent short term returns, both of which are very low right now. assume shadowstats measure of cpi, and its even much higher. Isn't this the way you are supposed to invest, in products and companies which are undervalued? Eventually rising food and energy prices feed through to the economy. The truth becomes known sooner or later. You always seek out the truth first, before you invest.
its also likely the Fed would be happy to pay you 3% on a 2yr note, while inflation is running at 5%. Why? To keep the dreaded glut of savings from stopping up the economy.
we know they have loaded the cannon, we know that when they fire the cannon the fixed income investors will be standing in front of it, like usual.
additionally the raid of equity, otherwise known as the housing bubble, which made people a lot poorer, will continue. the banks havent even gotten to the place where they start swapping paper and calling loans. those of you holding even small refis may find yourselves forced to pay up or renegotiate at much higher rates, and no one to lend that money at any price. if you have to stand in front of the cannon you should at least have a bulletproof vest, this is about survival people. this is not about making a few points off some gold bars and shouting booyah.
good people who have equity in their homes are going to lose those homes. wages will lag price increases, and the Fed will accomodate the difference because the public tends to think nominally, that 10% inflation is bad, 5% is acceptable, even if the premium to interest rates on savings is half that number. The government knows that they will never get caught paying double digit interest to those TIPs owners, but the real spread will be a killer, and all part of their plan to keep you spending, and buying shares in the stock market, of which you should do neither probably.
but on the outside chance that rates should explode, you will do quite well, unfortunately the best time to buy TIPs is probably over. that said if we get another deflationary leg lower, TIPS may again trade at discounts, and as Bob Prechter predicts massive deflation is usually followed by hyperinflation.
"To keep the dreaded glut of savings from stopping up the economy." - that made me laugh out loud!
For the rest you (grateful un...) summarize well; and it strikes me that the ongoing quiet seepage of inflation will be counteracted by sudden dramatic huge implosions of deflation - often in domino formations.
I recently came across this article and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Really a nice post here!
http://knowledgecloset.com/